|Index funds: a good driver of investment returns
Even if you don't play golf, you've likely observed
that there is more than one club in a golf bag. No one can play
a round of golf with just one club. You can't hit a tee shot with
a putter, you can't putt well with a driver and you can't use either
of those clubs on the fairway. Generally, every club in the bag
comes in handy at one time or another.
Here's a recent discovery I made: You really can hit
the ball farther with a Callaway Big Bertha War Bird than with an
off-brand driver. I recently got a hold of a secondhand one for
$30. Now I can drive the ball an extra 30 yards or so, which means
I use my 8 and 9 irons more frequently, since I drive the ball closer
to the green.
What does this have to do with personal finance? Golf
clubs are like mutual funds in an investment portfolio. You need
funds that represent various asset classes to get proper diversification,
and some should be more aggressive than others. Just as there are
optimal times to use particular clubs, there are always certain
asset classes that are outperforming at one time or another.
The secondhand War Bird would be the equivalent of
a cheap index fund that provides excellent yardage, or rather, investment
returns, over the long haul. We'll focus on this investment since
it should probably be the core holding in your portfolio.
What's superior -- passive or active investing?
The age-old debate about whether index funds are superior to actively
managed funds is "still raging," says Sonya Morris, a
CPA and funds expert for the mutual fund tracker Morningstar. But
get this: The average S&P 500 index fund beat 74 percent of
actively managed funds over the past decade. At various points in
recent history, I've seen the index funds pulverize anywhere from
67 percent to 90 percent of active funds, but the number seems to
be consistently way more than half.
"The typical active manager isn't going to beat a comparative index fund, particularly in more efficient areas of the market like the large-cap area," says Morris. "That's not to say there aren't a minority of very talented active managers who can beat the index over the long haul. But trying to find out who they are and locating them -- that's a very daunting and difficult task for most investors. And most investors have neither the time nor the inclination to look for those managers."
Count me among those who can't be bothered trying to keep up with the latest and greatest fund managers. This may sound heretical, coming from someone who used to pay close attention to money managers as a writer for a niche investment publication. I did so from 1995, when the S&P 500 index began posting gravity-defying returns of 20-plus percentage-points for five years running, and well into the unforgiving, savage bear market that followed.